Tax dodgers could be winners under ACA repeal

Tax dodgers could end up winners under Republicans' bid to repeal the Affordable Care Act.

One of the Obamacare tax provisions now at risk of being killed by lawmakers is aimed at cracking down on tax shelters. Known among experts as the "economic substance doctrine," it targets sham transactions used by businesses and wealthy individuals to avoid paying taxes.

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Though it has little to do with health care — Democrats only tapped the provision because it produced billions in savings, and they were desperate for ways to defray the ACA's cost — it may now fall by the wayside as part of the repeal effort.

The provision has been largely overlooked in the debate over rescinding the controversial health program, but some warn nixing it presents some political risk to Republicans.

“I don’t think the Republicans want to be politically exposed to [charges that] 'well, now you’ve made the world safe for tax weasels,'” said Dean Zerbe, a former Republican tax aide in Congress.

Though Republicans are divided over how far they need to go to replace existing Obamacare health coverage, they’ve repeatedly agreed to dump the economic substance provision. It was scotched under a leaked draft of their repeal plans — which Republicans say is outdated — and was a standard part of previous efforts to kill the ACA.

A House Ways and Means spokeswoman said Republicans are still discussing the policy.

The provision is one of more than a dozen revenue raisers Democrats used to help finance the health law nearly a decade ago.

Unlike those other provisions, which taxed everything from high-end insurance plans to flexible spending accounts to medical devices to prescription drugs, this one has nothing to do with health care. It is designed to make it easier for the IRS to go after tax shelters and other aggressive tax moves by targeting transactions that abide by the letter of the law, but not the spirit.

The doctrine was actually developed decades ago by the judicial branch, though different courts used varying standards.

By the time Democrats were casting about for ways to pay for Obamacare, the idea of codifying the doctrine at the federal level had been kicked around in Congress for years, and had won some Republican support. During the George W. Bush administration, the then-Republican controlled Senate agreed to the provision repeatedly, which lawmakers like Sen. Chuck Grassley (R-Iowa) wanted to use to pay for things like a farm subsidy bill, though it never made it to the president’s desk.

“I don’t think it was viewed as a purely Democratic proposal — Republicans were pretty keen on it too,” said Zerbe, a former Grassley aide.

The provision tucked into the Affordable Care Act created not just a uniform standard of which transactions flunk the doctrine, it also upped the penalties for failure.

Under the ACA, there has to be a legitimate business purpose to entering a transaction, beyond simply avoiding taxes, as well as economic substance to it. Otherwise it could be disregarded, even if it otherwise technically complied with the law.

“It’s got to be a real transaction and you have to have gone into it for real purposes,” said Daniel Hemel, a law professor at the University of Chicago.

The ACA also imposed penalties of up to 40 percent for barred transactions that taxpayers failed to disclose.

Congressional Republicans have said little about plans to repeal the provision, though Grover Norquist’s Americans for Tax Reform has been urging them to delete it.

“This provision allows the IRS to disallow completely legal tax deductions and other legal tax-minimizing plans just because the IRS deems that the action lacks 'substance' and is merely intended to reduce taxes owed,” its Web site says.

Said ATR Spokesman John Kartch: “We want each and every one of Obamacare’s taxes repealed.”

Many conservatives don't like the provision because it allows the IRS to nullify transactions deemed to violate the spirit of the law, said Ryan Ellis, a Republican tax consultant.

"If you're complying with the letter of the law, it's not up to the IRS to determine whether you're complying with the spirit," he said. "If you're following the law as written, then most conservatives believe that should be the end of the story. It's not up to the IRS to figure out your intent or to judge your motives."

Scrapping it would cost $5.8 billion over the next decade, according to the nonpartisan Congressional Budget Office.

But some warn it could end up costing more than that if Republicans follow up Obamacare repeal with a tax code rewrite.

That’s because lawmakers are considering some radically new approaches to tax reform, such as creating a so-called border adjustable business tax. That could inadvertently create new ways to duck the tax man, making the economic substance doctrine newly relevant, said Chye-Ching Huang, deputy director of tax policy at the liberal Center for Budget and Policy Priorities.

"It's hard for Congress to foresee every tax-avoidance opportunity that there is when they're putting together a complex piece of legislation," she said. “There is both potentially increased opportunity to do creative tax-avoidance schemes and also a potentially reduced cost of getting caught doing it."